CHART OF THE DAY: Crap Flies Farther Than Gold

Even as some investors questioned whether market expectations had run too far, junk (high yield) bonds rallied from December 1, 2009 through mid-January 2010. This followed an already stellar rally from March 2009 lows.

Over the same recent period, gold was beaten on a relative basis, as shown below using the iShares Corporate High Yield Bond ETF (HYG) and the SPDR Gold ETF (GLD) as proxies.

HYG (in blue) is up over the period, while GLD (in red) has fallen, despite the fact that both junk bonds and gold benefit from a continuation of the federal reserve's ultra-low interest rates. Note the chart doesn't even show any yield accumulated for bonds, which would enhance the comparison.

So are investors absolutely crazy to be buying up junk bonds? Maybe, but here's at least one rationale for doing so.

Economic recovery favors high yield bonds since default becomes less likely for companies, while it disfavors gold since the fear trade unwinds. Both benefit from continued low interest rates (as long as it doesn't trigger hyper inflation for bonds).

Thus high yield bonds bet on economic recovery AND a continuation of ultra-low interest rates --which basically means high yield bonds bet on a weak economic recovery. In comparison, gold bets on a double-dip recession/crisis.

Thus junk bond demand could be explained as the 'lame recovery trade'.

Given that a weak U.S. recovery looks more likely than an outright economic collapse these days, some investors are probably content to collect high yields while they watch America's stimulus-supported lame recovery grind forward. This is because during a weak recovery, stocks and gold could feasibly stay range-bound and go nowhere.

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